Market diverging from US Fed on QE expectations

No one is quite sure what the impact of US quantitative easing will be. Most commentary is that any interest rate rise will be slow and steady. But there is a huge divergence between the forecast for 2017 by the US Fed (as measured by the FOMC dot plot) and the market’s expectations.

Christopher Diaz, head of global rates and portfolio manager at Janus says the consensus it that an interest rate rise will be slow and steady. “We are not sure what the end of QE will look like, or when or how interest rates will go up. We are being told we’ll go slow and it’ll be ok.”

However in a presentation at the Fixed Income Forum on the impact of quantitative easing on bond prices, Diaz said there was “a 120 basis point difference between where the market thinks it will be in 2017 and what we’re being told by those setting the rate”.

“If there’s a rapid repricing up that could significantly disrupt markets,” he said. “So you wouldn’t expect to hold any asset except cash.”

The Janus house view is that the Fed will raise rates this September.

“Fed pricing is benign at best, complacent at worst. We expect the yield curve to flatten.”

Stuart Piper, head of fixed income at JANA, commented that he wished QE would go away. “It creates all sorts of distortions. It makes it a hard job for funds managers to manage rates when central banks are gobbling up supply and not letting markets do their jobs.”

Piper said one of the concerns for JANA is that it needs liquidity for its passive rebalancing of the portfolio, and QE can disguise liquidity.

“We have seen many false starts in Europe. I’m not that optimistic we won’t see the same thing happen in Europe.”

“US rates will go up a bit, spreads will widen,” he said. “Assets will move away from Europe chasing high yield in the US. Most of the action will be in the US which will be a recipient of capital flows.”

Diaz said he has some concerns around the riskier parts of the market. “If everyone heads for the high yield door at the same time, it could be a worry. The dealer community has very little capacity to wear it on their balance sheets.”

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